Barriers to Market Entry

Entry into a market is always in some way possible yet also constrained in some ways—except in purely theoretical descriptions. The two extremes are described by a state-supported absolute monopoly on the one hand (an insurmountable barrier to a new entrant) and a market on the other hand where entry has zero cost (a totally barrier-free market).

In actual practice, barriers to entry are always present to a new entrant in the very nature of things: some investment is always required, however minimal it may be. If the market already exists, some unusual effort to convince existing customers to buy, and channels to carry the goods will be required. The subject of barriers, therefore, in academic or policy contexts, turns on the concept of maintaining a healthy degree of competition or, in international contexts, fair access to markets. Economic theory asserts that competition holds down prices and thus contributes to the common good. The natural tendency of competitors in the market is to limit competition in order to raise profits to a maximum. A conflict is inherent. Given the great complexity of markets and the presence of all manner of historical, locational, technical, and other advantages, sorting out "natural" and "artificial" barriers to entry or international trade is a never-ending activity.

The major categories that translate into barriers are cost, capital, know-how, location, and state power. These factors are complexly intertwined. To give a few examples: A company with an absolute cost advantage may have acquired it by investing large amounts of capital, by ownership of patents no one can use except at a high cost, by being located in a region of extremely low labor cost, or because it is highly subsidized by the state. Know-how is often based on patents; patent protection is provided under state laws. A current controversy concerning growing Chinese imports involves very low wage rates in China and Chinese governmental manipulations of currency to keep costs in the U.S. low. These actions are said to create barriers to entry into markets by American entrepreneurs who have high labor costs.

In a recent paper published in the Journal of Business and Industrial Marketing, Fahri Karakaya reported the findings of a literature search aimed at determining barriers to entry by all kinds of enterprises. Karakaya found the following top-ranked barriers: 1) absolute cost advantages enjoyed by the incumbent, 2) economies of scale, 3) product differentiation, 4) the degree of firm concentration, 5) capital requirements to enter a market, 6) customers' cost of switching, 7) access to distribution channels, and 8) government policy.

Economies of scale are another form of cost advantage, specifically lower acquisition costs for raw materials (bulk purchasing) and lower overhead (overhead absorbed by more operations). Product differentiation, similarly, represents the consequences of investment in new and specialized products. Firm concentration is another way of saying that oligarchic structures prevent entry. In such cases, often, access to distribution channels is also difficult. The cost of switching customers occurs frequently in modern industrial times in which highly integrated technical products play a role. It is difficult, for example, to cause a customer to replace a well-established computer system with a new one. The cost savings must be very high. Anyone who has ever installed a new operating system will understand.

Karakaya also conducted his own survey of executives, concentrating on industrial enterprises. His survey disclosed similar but slightly different rankings. The first eight barriers cited by his respondents were 1) absolute cost advantages, 2) capital requirements, 3) incumbents with superior production processes, 4) capital intensity of the market, 5) incumbents with proprietary product technology, 6) customer loyalty advantage held by the incumbent, 7) incumbents with economies of scale, and 8) amount of sunk cost involved in entering the market.

All of the above applies equally to very large would-be entrants to a market and the aspiring small-business entrepreneur. The small business owner will benefit by entering a market poorly served locally, especially if he or she has a special cost advantage, an unusually good location, and product differentiation sufficient to attract new customers easily. Ultimately "barriers to market entry" can be translated into another phrase: "stiff competition."